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Daniel J. Ivascyn, Alfred T. Murata
Generating income while preserving capital are important goals for many investors, yet they are increasingly difficult to achieve in today’s uncertain financial markets. Dan Ivascyn and Alfred Murata, recently named Morningstar’s 2013 Fixed-Income Managers of the Year, discuss the strategy and philosophy behind PIMCO Income Strategy’s success and what they expect in the year ahead.
Q: What, in your view, sets PIMCO Income Strategy apart? Dan Ivascyn: While there are many strategies that focus on income generation, the Income strategy focuses on both income generation and capital preservation. Given today’s uncertain financial markets, we believe the latter is increasingly important – not only considering the return on one’s capital, but perhaps more meaningfully, concentrating on the return of one’s capital. The strategy’s combined objectives mean that we won’t stretch for yield by sacrificing downside protection – something that differentiates us from strategies that simply aim for the highest yield. Nevertheless, we think it’s possible to deliver a consistent distribution as well as attractive total return by taking advantage of the most attractive income ideas in the global bond market.
I would also like to say that both Alfred and I are very honored that Morningstar has recognized the process that we use to add value for investors. I also want to stress that the strategy’s performance has been driven by the bottom-up investment ideas provided by PIMCO portfolio managers across the globe and the top-down PIMCO investment process.
Q: Can you describe your income management philosophy? Alfred Murata: In order to pursue our dual goals of income generation and downside protection, there are three major themes that we are looking to exploit in the Income strategy. The first is flexibility. Instead of managing the portfolio with a goal of outperforming a particular benchmark, we construct the portfolio with the goal of achieving our objectives of generating attractive income, capital appreciation and capital preservation. This provides us significant leeway in adjusting sector concentrations and risk measures as the opportunity set changes.
The second theme is harvesting a global opportunity set. Although asset valuations are becoming increasingly driven by a small number of underlying drivers such as Fed policy, there still remain significant valuation differences within and between asset classes and across geographies. A material advantage of PIMCO Income Strategy is the opportunity to use the insights from PIMCO’s top-down process combined with the bottom-up investment ideas provided by numerous portfolio managers and analysts across the globe.
The final theme relates to focusing on protecting capital. One way that we express this theme is to invest in assets that are senior in the capital structure, which we expect to be more resilient in the face of negative economic developments. Another way we implement this theme is by investing a portion of the portfolio in assets such as Australian interest rate duration and agency mortgage-backed securities, which we expect to appreciate in the event of negative economic developments.
Q: What are some other high-conviction strategies? Ivascyn: In the current environment, we think that it’s important to focus on being defensive. In an effort to achieve the objectives of income generation and capital preservation, we divide the portfolio into two components, one component comprising higher-yielding assets, which we expect to outperform if economic growth is strong, and the other comprising higher-quality assets, which we expect to outperform if economic growth is weak.
Within the higher-yielding component of the portfolio, we continue to see value in U.S. non-agency mortgage-backed securities. We find these securities to be attractive because we’re able to buy these bonds at a significant discount from par, which provides a “cushion” in the event that economic conditions end up being worse than anticipated. These securities can also go up in price if economic conditions end up stronger than anticipated.
Within the higher-quality component of the portfolio, as Alfred mentioned, we find Australian interest rate duration to be more attractive than U.S. Treasuries given the combination of higher nominal yields, higher real yields and a central bank that has been significantly less active in compressing yield premia to date.
Q: How does PIMCO Income Strategy pursue a distribution that’s both high and consistent while still seeking an attractive return? Murata: We don’t think that generating income and total return are mutually exclusive goals. While we’ve been able to keep the distribution steady, I can’t stress enough that the strategy will never pay out a rate that is irresponsible or compromises our goal of capital appreciation. Although the ability to take advantage of a global opportunity set maximizes our ability to pursue both objectives simultaneously, in the event that the opportunity set contracts materially, we would reduce our distributions instead of reaching for yield.
Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss.
There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should evaluate their ability to invest long term, especially during periods of downturn in the market.
This material contains the opinions of the managers but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Allianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. ©2014, PIMCO.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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